The Nation: Are the Savings Real?; Paying the Price for Tax Cuts

By PETER PASSELL

Published: October 2, 1994

IT'S election season and tax cut fever is upon the land. Taking a cue from Christine Todd Whitman's successful campaign for governor in New Jersey last year, George Pataki, the Republican gubernatorial candidate in New York, is calling for a 25 percent reduction in income tax rates -- savings, he argues, that are possible without adverse consequences to localities dependent on state aid.

But when is a tax cut really a tax cut? Experience has shown that, barring an economic boom or a large amount of obvious fat in the budget, cuts at one level of government are often made up for by tax increases at another. The alternative is a reduction in services. If history offers a fair test, suggests Helen Ladd, an economist at Duke University and the Brookings Institution, it is in California and Massachusetts, where the consequences of local property tax rollbacks have been reverberating through government at both state and local levels for more than a decade. And here, argues Ms. Ladd, "the chickens are coming home to roost" in the form of higher state taxes or as deterioration in the quality of popular public services.

This year a number of states, notably Michigan, Arizona, New Mexico and New Jersey, have cut taxes. And in most states with elections, candidates are jockeying for the high ground as tax-busters. But Steven Gold, an economist at the Rockefeller Institute at the State University of New York at Albany, notes that, over all, cuts will pare less than $2 billion from these states' revenues, a hardly noticeable sum from budgets that exceed $350 billion. "The lesson so far is no lesson at all," he said. The cuts have been too small to prove much.

Where big cuts have been enacted, says Michael Brooks, a municipal bond specialist at Sanford Berstein, "you have lots of things happening at once," clouding measurements of cause and effect.

In New Jersey, Ms. Whitman largely relied on $1.8 billion in one-shot savings -- mostly from the state employee retirement plan -- to finance a 5 percent reduction in income taxes. And last week she conceded that her promised 30 percent reduction may have to be phased in over four years rather than three. Michigan was able to slash state property taxes dedicated to education. But Mr. Gold points out that state and local coffers are benefiting from economic recovery and a boom in auto sales; the "piper will be paid" later on, he predicts, when the growth of sales taxes slows.

That theme has echoes in the experiences of California and Massachusetts, where local property tax revolts in the late 1970's led to sharp reductions in the capacity of local government to generate revenue.

David Hensley, an economist at Solomon Brothers, notes that California was "sitting on a large bankroll" when Proposition 13 was passed in 1978. Localities were able to shift the tax burden to Sacramento, meaning that taxpayers ended up "refunding" their property tax savings through income and sales taxes.

By the same token, notes Ms. Ladd, "the time frame is crucial" in assessing the consequences of a local property tax freeze in Massachusetts. The "Massachsetts miracle" -- the dramatic expansion of the economy in the early 1980's -- that propelled Gov. Michael Dukakis into the national consciousness also enabled the state to use increased tax revenues to cover much of the shortfall experienced by towns and cities. Recession Strikes

In both states, though, recession ultimately altered the fiscal equation. California was forced to raise the state sales tax in 1991, and then forced to postpone a scheduled rollback in the sales tax in 1993 to protect state aid to localities. William Weld, Massachusett's Governor, refused to raise taxes to cover projected budget deficits, relying instead on cuts in outlays on infrastructure and health services. Ms. Ladd, who has studied Massachusetts local finances in considerable detail, concludes that "municipalities are really hurting." Most, she says, are dipping into rainy day reserves to protect crucial services.

While there are few "supply side" purists around these days to claim that lower tax rates offer a free lunch by igniting an economic boom, most economists agree that there are offsetting benefits to be had from luring businesses (and thus jobs and a larger tax base) from high-tax states. But as Mr. Gold points out, this is a zero-sum game: Competition among states will eventually nullify the positive impact.

A more plausible defense of tax-cutting is that it is the only practical way to force states to contain spending. The catch, of course, is that while everyone seems to agree that state and local government is rife with waste, the politics of budget-cutting do not necessarily serve the public interest. "People think waste can be skimmed off the top like cream from old-fashioned milk bottles," says Ms. Ladd. "But government budgets are more like homogenized milk" -- with the fat evenly mixed with the good stuff.